When I think of all the worries Keynesians seem to find
And how they’re in a hurry to complicate their minds
By chasing after money with nothing else in view
Austrians are different, we see the problem through
(sung to “Let’s Live for Today,” with apologies to the Grassroots)
In a recent series of blog posts on the meaning of saving, Bob Murphy gives the following example intended to illustrate and defend his interpretation of the concept of saving:
15-year-old Johnny mows my lawn every week, and I pay him $20 each time. Every week, he spends $15 of it going to the movies with his friends, but he puts $5 in a piggy jar on his bureau.
After a year, he has accumulated $5×52 = $260 which he uses to buy a nice watch. Johnny says, “I’m sure glad I consumed less than my income all year, saving $5 per week. Then I used my accumulated savings to buy a watch. I deferred consumption all year in order to buy a nice good later on.
Bob then goes on to ask rhetorically, “Are you guys all comfortable with that? You don’t think Johnny was saving $5 per week?”
Although debates about the meaning of words are always treacherous and seldom fruitful, in this case, I believe we can add some clarity to the conceptual issues at stake by analyzing Murphy’s simple example more closely.
Unspecified in Murphy’s example is exactly when little Johnny goes to the movies. Let us suppose that he regularly cuts Murphy’s lawn and receives his pay of $20 on Monday and spends $15 going to a matinee with his friends the following Sunday. Everything else remains as specified in the original example. Thus, in order to carry out this plan, Johnny must retain $15 of his weekly income in his cash balance for a full week. The question that immediately arises is whether this would also be considered saving by Murphy. Indeed little Johnny could easily say, presumably without fearing contradiction from his economist-employer, “I deferred consumption all week in order to see a good movie later on.”
Now, let’s tweak the example a bit. Let us say that Johnny is always thirsty after he cuts Murphy’s lawn, because Murphy refuses to supply him with refrigerated bottled water and permits him only to drink the warm, coppery-tasting swill from his garden hose. So Johnny routinely goes to the local convenience store and orders a big Slushy for $2 one hour after he cuts Murphy’s lawn. (He therefore foregoes a large tub for a small bag of popcorn at the movies the following Sunday.) But this wouldn’t this be just as much saving according to Murphy, because Johnny holds the $2.00 in his cash balance, refraining from consumption for a full hour?
The broader point that emerges from this analysis is that Murphy is simply defining “saving” as the holding of cash balances. For consider the ineluctable fact that in a monetary economy everyone must retain a money payment in his cash balance for a shorter or longer period of time, whether he intends to purchase an immediately consumable service like a movie or restaurant meal, a consumer durable like a car or a house, or an investment asset of some kind. In other words, all income and spending (on both consumption and investment) must flow through cash balances. It follows from the very nature of money as the general medium of exchange that there is always a lapse of time between monetary receipts and expenditures. Whether it is a matter of hours, weeks or years, money income once received must always be held in cash balances before it can be spent.
Getting back to Murphy’s main argument: Is it therefore his contention that all monetary income is necessarily saved because it is held for a time in cash balances? If not, then what is his criterion for distinguishing those parts of cash balances that constitute “saving” from those that do not? It would seem that any attempt to establish such a criterion would be entirely arbitrary. Is money that is spent on consumer goods within a month, a week, 5 hours, 15 minutes of its receipt considered consumption or saving? Where is the line to be drawn?
Let us change Murphy’s example one more time to illustrate the point from another angle. Suppose that Murphy is the franchise owner of the local multiplex theater and also a silent partner in a local jewelry store. Assume further that he makes a deal to pay Johnny a voucher for a matinee ticket and concession items worth $15 plus a $5 credit to Johnny’s layaway account for a watch at his jewelry store. In this scenario Johnny receives and holds no cash balances, precisely because money enters the transaction only as a numeraire or accounting device and not as a true medium of exchange; in effect, Johnny’s income and expenditures are simultaneous, i.e., he purchases the movie voucher and layaway account credit instantaneously upon receiving his money. Nonetheless Johnny achieves exactly the same ends on the market—a movie every Sunday and a watch at the end of the year—as he does when he is compensated in money.
Thus, however Murphy may wish to characterize Johnny’s temporal pattern of consumption in relation to his receipt of income, it has nothing to do with the holding of money. In the case in which Murphy compensates Johnny with money, Johnny earns $1,040 (= $20 x 52) and holds an average daily cash balance during the course of the year of $145 (= $15 every day + $260/2—assuming for ease of calculation that he holds the $15 for the entire day each Sunday rather than only part of it). In the second scenario Johnny also earns an annual income of $1,040, but now he holds an average of zero cash balances. So to put the question at issue in another way, does Johnny save any more in scenario two compared to scenario one just because he holds $145 in cash on average? Murphy must answer this question and those posed above in order to make his definition of saving coherent and meaningful.
{ 19 comments }
Are you going to answer Mr. Fekete? concerning fly elephant and money for lunch.
thanks from libertarian in Spain.
Johny saves by postponing his call on other goods and services. The longer the postponing, the longer the production structure it allows. Saving for sunday vs. saving for a year demonstrates this effect.
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And if you pardon my french, the vouchers are still means of indirect exchange and so I’d count them to be a sort of money too.
Except that after the year is up the structure gets shorter again. Everyone can eat every day or once a year. So the market would adjust to accommodate the spending habits of the consumers. If 1 loaf of bread is baked a day for each person, or 360 loafs once a year for each person, then yes, it’s a different structure of production, but not necessarily a longer one. The point is that switching from 1 bread/day to 360 breads/year is a different structure but not a longer one.
There would have to be a permanent increase in reservation demand for money coming about by reducing spending on consumption only, or more so then on spending on future goods (direct investments) for their to be a permanent shift in time preference. This would permanently lower interest rates, however, it is not the demand for money that caused this lowering of the interest rate, but a fall in time preference which happened to accompany an increase in reservation demand for money.
I see scenario #2 as direct exchange. The vouchers aren’t a medium, they’re simply proof of the transaction – so the ticket taker let’s you in the door.
It doesn’t matter, though, whether a medium of exchange is used or not. Johnny delays consumption of his production. Any delay between production and consumption is savings.
I have a return question. Would my body be considered a durable consumable?
” in effect, Johnny’s income and expenditures are simultaneous, i.e., he purchases the movie voucher and layaway account credit instantaneously upon receiving his money. ”
Obtaining the movie voucher isn’t consuming. Neither is the purchase of the layaway credit. They are both claims on a future good/service and therefore an asset.
“So to put the question at issue in another way, does Johnny save any more in scenario two compared to scenario one just because he holds $145 in cash on average?”
No, but the reverse is true as well. His pattern of income hasn’t changed and the pattern of his consumption hasn’t changed. Therefore, his saving behaviour hasn’t changed.
I’ve read all the blog posts on this debate (and skimmed Murphy’s dissertation) and it seems to me is that Murphy has a fundamental problem with the Austrian Pure Time Preference Theory of Interest. His objection seems to stem from the fact that when a person adds to his cash balance, he “saves”, even though he his not compensated for foregoing present consumption as the Austrian theory suggest one must be else he would not save. Thus, Murphy is suggesting an alternate theory of interest in needed.
I found a good article from Hoppe in this regard, “The Yield from Money Held” http://mises.org/daily/3449
Basically, Hoppe suggest that holding cash is mans means of navigating uncertainty (in the Knightian sense) about the future, or as Mises called it case probability. He writes, “Thus, just as insurance premiums are the price paid for protection against risk aversion, so cash holdings are the price paid for protection against uncertainty aversion.”
“To invest in cash balances means, I am uncertain about my present and future needs and believe that a balance of the most easily and widely saleable good on hand will best prepare me to meet my as-of-yet unknown needs at as-of-yet unknown times.”
In other words, man would invest in financial assets of a specific maturity IF he knew exactly when he is going to need those funds. To the extend that people do invest in these securities, they do so because they are certain about the timing of their need to use those funds. Man invests in cash if he is uncertain about his future needs.
I don’t think this is inconsistent with the time preference theory of interest in that man is still being compensated for parting with present consumption, but rather than the compensation taking the form of a yield, it takes the form of protection from uncertainty. If a cash balance did not provide the necessary compensation, he would simply consume the funds instead.
I think Hope and Pacia basically have it right here. Let me say though, it isn’t that people must be compensated in order to save. The idea that if the real interest rate were zero everyone would consume all their wealth immediately is, of course, unrealistic. People have some preferences over different goods at different times. Johnny prefers a movie on sunday to whatever he could buy with $15 on monday, so he saves even though he is not directly compensated for doing this. The important point is that people will save more when they are compensated more, and in a free market (if such a thing existed) the demand for real savings at a zero real interest rate would be greather than the supply and the market clearing real interest rate would be positive.
Then the issue is in what form to hold savings. Some options are more desirable than others because they are more liquid so people must be compensated for holding less liquid assets (bonds vs. cash for instance). This is where the spread between the real an nominal rate come from. (This raises some interesting implications with inflation in our current system, for more on that: http://realfreeradical.wordpress.com/2011/03/31/monetary-theor…ation-approach/) In this case the foregone return is the price of additional flexibility which people are willing to pay because they are, as already mentioned “uncertain about [their] future needs.” Interesting, this is essentially the concept of “liquidity preference” (although that may be a bad word around here, I’m not sure….).
If you ground it in reality (the science of human action) you may have something going for it.
If you ground it in gobbledygook you’re going to get flak from real economic scientists, but praise from academics if it justifies their worldview that they’re smarter than everybody else and everyone would be better off if they were running things (and carte blanche for interventionism)
Could you explain the difference? (This is an honest question, I’m basically on your side)
“Unspecified in Murphy’s example is exactly when little Johnny goes to the movies. Let us suppose that he regularly cuts Murphy’s lawn and receives his pay of $20 on Monday and spends $15 going to a matinee with his friends the following Sunday. Everything else remains as specified in the original example. Thus, in order to carry out this plan, Johnny must retain $15 of his weekly income in his cash balance for a full week. The question that immediately arises is whether this would also be considered saving by Murphy. Indeed little Johnny could easily say, presumably without fearing contradiction from his economist-employer, “I deferred consumption all week in order to see a good movie later on.” ”
A: Right – the holding of money for the purpose of consumption spending should not be considered savings at all.
“Now, let’s tweak the example a bit. Let us say that Johnny is always thirsty after he cuts Murphy’s lawn, because Murphy refuses to supply him with refrigerated bottled water and permits him only to drink the warm, coppery-tasting swill from his garden hose. So Johnny routinely goes to the local convenience store and orders a big Slushy for $2 one hour after he cuts Murphy’s lawn. (He therefore foregoes a large tub for a small bag of popcorn at the movies the following Sunday.) But this wouldn’t this be just as much saving according to Murphy, because Johnny holds the $2.00 in his cash balance, refraining from consumption for a full hour?”
A: In fact the spending on the drink, to the extent it is considered support in the undertaking of production, should be considered savings, and a capital expense, rather than consumption. Just as labor is a production cost, so would be sustaining one’s labor.
“The broader point that emerges from this analysis is that Murphy is simply defining “saving” as the holding of cash balances. For consider the ineluctable fact that in a monetary economy everyone must retain a money payment in his cash balance for a shorter or longer period of time, whether he intends to purchase an immediately consumable service like a movie or restaurant meal, a consumer durable like a car or a house, or an investment asset of some kind. In other words, all income and spending (on both consumption and investment) must flow through cash balances. It follows from the very nature of money as the general medium of exchange that there is always a lapse of time between monetary receipts and expenditures. Whether it is a matter of hours, weeks or years, money income once received must always be held in cash balances before it can be spent.”
A: I agree. Whether a cash holding is considered savings or not, hinges on the purpose of the holding. If it is to be spent on (invested in) land or labor in the pursuit of production, it is savings. If it is for consumption, it is not savings. The ultimate question regarding the expense on the watch is not how long one held cash before buying it, but what is the purpose of the watch. Is it to advance the goal of production, or is it for the personal enjoyment of a nice watch to wear to the movies, for instance.
“Getting back to Murphy’s main argument: Is it therefore his contention that all monetary income is necessarily saved because it is held for a time in cash balances? If not, then what is his criterion for distinguishing those parts of cash balances that constitute “saving” from those that do not? It would seem that any attempt to establish such a criterion would be entirely arbitrary. Is money that is spent on consumer goods within a month, a week, 5 hours, 15 minutes of its receipt considered consumption or saving? Where is the line to be drawn?”
A: Right. The question can only be: what is the purpose of the thing bought – is it for production or consumption. If the former, the cash holding is savings, the latter, pure consumption.
How is spending on a drink support of production (and therefore investment) but spending on a movie is not? Doesn’t spending on a movie support the production of movies just as much as spending on a dring supports the production of drinks?
If the spending on the drink is to increase johnny’s ability to produce, then its a spending on production. IE to be a spending on production it must support or increase the production of the one spending the resources. For example, If the owner of a company uses the profit to purchase a new car, that is spending for personal consumption and doesn’t increase the company’s productivity. But if the owner of the company spends the profits on a new set of production equipment that will reduce the cost per item by increasing the number of items produced, then its spent on production. And the resources accumulated for that purchase would be an example of savings.
Yeah baby!
Ok I get what you’re saying I think: that the drink is an input to the mowing of lawns. It seems from the story that this is a stretch since he only bought the drink because it tasts better than the hose water that he otherwise had access to but I guess that’s a silly thing to argue about.
There seems to be some confusion here between saving and investment. By saving money (not investing it just holding onto it) it frees up resources which you could have consumed for other purposes, including to support a longer capital structure in order to supply more goods at some point in the future when you actually spend the money, regardless of what you spend it on at that time. Oviously, if you save it for a week, this does not help support as long a capital structure as if you save it a year but the principle is the same it’s just a matter of magnitude.
Here is my response to Salerno, if anyone is still checking this thread.
Thanks.
Yup. Still checking.
1. I agree with Murphy that cash balance is saving, but this is only true when the cash is earned or produced, not fiduciary media created by FRB. Why cash balance is saving is clearly illustrated in the chapter 7 and 8 in Murphy’s “Lessons for young economist”. In indirect exchange, holding cash means the deferral between supplying goods/services now and actually redeem for good/services in the future. There is no doubt that cash balance yield zero monetary return, however, holding cash balance itself had tremendous benefit compared to a barter economy. There is no difference between holding and hoarding. The purpose of the holding is irrelevant to whether cash holding is saving. The crucial point is where that income comes from?
When Bernanke print money and lend out to government to spend, then holding these money should not be considered as savings, as there is nothing saved behind the these cash. They rather stand for legal robbery tickets towards existing property owners.
When talking about cash holdings, there is no value free analysis. You have to ask what income is, should money printing be considered legitimate income?
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